In a question and answer session with senior members of parliament, Blair said the International Atomic Energy Agency (IAEA) decision to report Iran to the UN Security Council was "an important first step".

"We have got to discuss with allies how we proceed. The answers are not easy," he said.

He reiterated that military action against the Islamic republic was "not on our agenda" and that he hoped the simmering crisis can be resolved through diplomatic means.

"It is interesting that over the past few months there has been a change of mood in Europe as well as in the United States," Blair told the House of Commons liaison committee.

"Iran would make a very, very serious mistake if it thinks the international community is going to allow it to develop nuclear weapons capability."

Iran suspended voluntary cooperation with IAEA inspectors after the UN watchdog voted 27-3 last Friday to report its concerns about Tehran's nuclear programme to the UN Security Council, which could impose sanctions.

Iranian President Mahmoud Ahmadinejad contends that his oil-rich nation wants to develop nuclear power for civilian energy needs.

But Blair argued that Iran's credibility with the rest of the world remains in question after Ahmadinejad last October called for Israel -- which is suspected of having its own nuclear capability -- to be "wiped off the map".

"When its president makes statements such as the ones that are made about the state of Israel, that enhances people's concerns about the fact of their having a nuclear weapons capability," he said.

"When they are then in addition trying to export and support terrorism around the whole of that (Middle East) region, it's a problem. When they're trying to meddle in Iraq, it's a problem.

"These problems, which they combine together, then give the international community more concern in respect of the programme that they say is merely a nuclear energy programme."

Britain, together with France and Germany, has been involved in negotiations with Iran on the nuclear issue on behalf of the European Union, with support from the United States.

Earlier Iran has told the International Atomic Energy Agency to remove surveillance cameras and agency seals from sites and nuclear equipment by the end of next week in response to referral to the UN Security Council, the agency said Monday.

Iran's demands came two days after the IAEA reported Tehran to the council over its disputed atomic programme.

In a confidential report to the IAEA's 35-member board on Monday, agency head Mohamed ElBaradei said Iran also announced a sharp reduction in the number and kind of IAEA inspections, effective immediately. The report was made available to The Associated Press.